Climate change is an environmental externality wherein firms and households do not have to pay for the damage that their emissions impose on others. This reduces pressure to create new technologies to mitigate greenhouse gasses (GHGs). Moreover, once any innovations are discovered, knowledge spillover means that the innovating company cannot capture all of the benefits of research and development (R&D).
A proposed economy wide carbon tax or a cap-and-trade system that places a cost on GHG emissions—coupled with an R&D tax credit for climate-related innovation—would induce private sector innovation around mitigating GHGs. The federal government could double its current climate-related funding, increase the amount of prize-based R&D funding, and improve management and coordination with the Department of Energy around climate-change technologies.
Within a market-based economy, success is maximized if policies directly address specific market problems. For technology innovation relevant to mitigating greenhouse gases (GHGs), the two principal market problems are a lack of private incentive to reduce GHGs by adopting low-GHG technologies, and underinvestment by industry in research and development (R&D), especially basic research. The strategy thus has two main parts to directly confront these two market problems, thereby increasing both the demand for and the supply of GHG-reducing innovations: 1) inducing innovation in industry through a stable, long-term price on GHGs, reinforced by permanent R&D tax credits, and 2) complementing this innovation through increased public support for targeted climate mitigation research in universities, other research institutions, and in the private sector.
The innovation strategy specifically recommends gradually increasing federal spending for climate mitigation research to roughly $8 billion per year over the next eight years, or roughly doubling energy research from 2007 levels by 2016. This increased funding should prioritize strategic basic research inspired by critical needs arising from efforts to develop new and improved GHG mitigation technologies, and should invest in training the next generation of scientists and engineers. Increased resources need to be tied to an effective management and coordination strategy for research focused on climate mitigation technology to ensure these funds are employed efficiently. Finally, a portion of these funds should be targeted to inducement prizes that provide financial rewards for achieving significant advances in climate mitigation innovation. In doing so, these funds would engage a broad set of innovators.